The latest Chinese FX reserves data for May suggest an improving backdrop for the currency, rising to $3,128B, from $3,120B in April. This brings to an end the longest streak of declines in reserves since 2016. But the data flatter to deceive. The gain in reserves came during a period of renminbi weakness, and was driven by currency and asset valuation effects. Absent euro appreciation, and a rally in US fixed income, May would have seen another decline.
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We estimate that currency moves, particularly gains in the euro against the dollar, led to a revaulation of China’s FX reserves by over $15B in May. In addition, a rally in US fixed income likely added around $150B, though the precise composition of FX reserve assets is unknown. As headline reserves rose by only $8B, this implies significant outflows, even if our estimates are on the high side. June will likely see a significant drop, without further assistance from valuation effects.
The persistent caution of the PBoC is a better sign of the continued pressure facing FX reserves, and the renminbi. China’s central bank continues to drain liquidity, as shown in our chart above, despite a very clear pivot from Beijing towards growthsupportive policies, including a push to improve credit support for infrastructure and property.
The PBoC’s reluctance to ease can be explained by the likely consequences for the renminbi. Liquidity injections drive down Chinese bond yields relative to those elsewhere, and this narrowing interest rate differential—now negative, vis-à-vis the US— generates capital outflow pressures. If China really had returned to positive net inflow territory, this would be less of a concern.
The PBoC will not be able to resist Beijing’s entreaties indefinitely, however, and banks remain leery of extending new credit. Fresh liquidity will be needed by Q3, renewing the pressure on the renminbi.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
